How are Payroll Taxes Calculated? – Federal Income Tax Withholding

Federal income tax withholding is an estimate, but do you know how to project your desired withholding amount? Payroll guru Matt Keller provides answers.

Bookmark (0)

No account yet? Register

Understanding your W2 forms

In my previous blog we looked at the best methods for determining our federal income taxable wages. Now that we know our taxable wages, we’re ready to calculate the federal income tax withholding.

Federal Income Tax Withholding is an Estimate

The first thing to remember is that federal income tax withholding is an estimate. Its mission is to try to get as close as possible to the taxes you owe when you file your annual personal income tax return. If you did not have enough withheld from your paychecks during the year, you will pay the extra amount owed when you file your return. If you had too much withheld during the year, you will receive a refund from the IRS after you file your return.

Payroll systems cannot know your mortgage interest, your medical, your tuition, or other itemized deductions. The withholding calculations are based on IRS guidelines from Publication 15 (also known as the Circular E).

The tools you have to impact your withholding amount are your marital status, your allowances, and additional amounts to add each pay period. A withholding status of married assumes that the other spouse is not working, so the withholding calculation is lower. If you owed federal income taxes the previous year with a married status, there is an option to withhold at the higher single rate to increase the withholding.

Allowances are employee exemptions from income tax withholding. They often represent the number of dependents one can claim, but can also be used for mortgage interest and other itemized deductions that can be claimed on your personal tax return. They reduce the wages considered for the withholding calculation (but they do not reduce the actual income recognized for taxes).

Below are the values from the IRS Circular E of a single allowance based on the payroll period:

Withholding allowances from the Circular E

Projecting Your Desired Withholding Amount

If your income from year to year is relatively stable, and you do not receive significant bonuses or commissions, one way to determine a proper withholding amount is to take your total personal income taxes paid from the previous year, and divide that amount by the number of times you are paid during the year. For example, if my total tax on my personal tax return (line 63 from the 1040) was $10,000 and I am paid semi-monthly (twice a month), I may want my withholding per check to be $416.67 ($10,000/24).

A tool that you can use to help you determine the marital status and allowances required to arrive at your desired withholding amount is the IRS Withholding Calculator.

What are Supplemental Wages?

Supplemental wages are wage payments that aren’t regular wages. They include, but are not limited to, bonuses and commissions, awards, and prizes. The IRS expects these earnings to either be included with regular earnings, or if paid out by themselves, withheld using a “supplemental rate” of 25%. If you are lucky (and skilled) enough, you will be taxed at a rate of 39.6% for all supplemental wages over…


Image source

So when you’re considering an annual amount of taxes you want to pay through payroll, you need to consider the supplemental wages you will earn, and the tax rates associated with those supplemental wages.

Now that we better understand federal income tax withholding, it’s time to look at social security and medicare taxes, which I will discuss in my next blog.

For a complete list of Matt Keller’s payroll blogs, check out our Money Matters section.

Bookmark (0)

No account yet? Register

Might also interest you